Why Canada stands a good chance of surviving scary fiscal cliff ride

OTTAWA – America going over the fiscal cliff in January will likely be more of a bumpy toboggan slide for Canadians.

The prospects that U.S. lawmakers won’t be able to find the goodwill to arrive at a compromise to prevent a $670-billion economic shock in 2013 dimmed considerably Friday after a vote failed and the House of Representatives headed home for the holidays.

The smart money bet that Republicans, despite their humbling loss in the November elections, couldn’t bring themselves to swallow even the mildest tax hike needed to arrive at a deal with the Democrats.

U.S. President Obama called on lawmakers to pass legislation that will ensure everyone gives “a little bit in a sensible way.” He said he still hopes a deal can be reached before Jan. 1.

But analysts note that even if Congress doesn’t step up prior to Dec. 31, the world doesn’t necessarily end on Jan. 1.

“This is not like a light switch that goes on or off,” says Doug Porter, deputy chief economist with BMO Capital Markets.

“Things will change, but there are still all kinds of scenarios where the economic damage could be quite limited if policy-makers do respond quite quickly.”

A detailed analysis by TD Bank calculates that if the fiscal hit lasts throughout 2013, the U.S. will lose three percentage points from growth, which means the economy would contract by about one per cent.

“In turn, Canada’s economic turnout would be clipped by between one and 1.8 per cent,” the report estimates. That’s a significant haircut, but it also suggests the economy will likely be able to keep its head above water, if at nose level.

TD offers a proviso that economic behaviour has a human element, so not all the repercussions can be calculated to decimal points. The loss in confidence, panic even, could be make things much worse than economic models suggest.

“These estimates do not include the economic impact of financial volatility (stock markets) that would occur if there was a failure to reach a resolution, which raises the risk that Canada would follow the U.S. into a recession.”

This week, Finance Minister Jim Flaherty said he would respond appropriately if the worst occurs, and he expressed confidence provincial finance ministers would follow suit as well.

“The federation does tend to pull together — particularly the finance ministers because we all deal with the numbers — when times get tough,” he said prior to meeting his provincial counterparts for a one-day discussion of issues.

The federal minister has said he would act to stimulate the economy much as he did in 2009, although nobody expects a major stimulus budget.

More likely, said Porter, Ottawa will allow the deficit to rise, and the Bank of Canada will cut interest rates further to provide some mild stimulus.

But analysts note the fiscal cliff in the U.S. is a misnomer. A better term would be a “fiscal slope” because the fall off does not occur all at once. The longer it goes the worse it becomes, but the shorter the duration, the less the impact.

The oft-talked scenario is that after talks fail, President Barack Obama will quickly propose tax cuts for the middle class — but not the affluent — and reinstate a majority of the pre-existing spending levels.

That would give Republicans who had signed a no-taxes pledge cover to defend their actions, since they would have not voted to increase levies even on the super-rich.

Flaherty suggested as much this week when he said he expected a deal sometime in January or February.

“It’s absolutely not a crisis,” said Finn Poschmann of the C.D. Howe Institute.

“This can be stopped at any time by a deal and there’s something you need to know about the U.S. Congressional system — it’s that nothing is ever finished.

“The process adjusts all the time to manage transitional outcomes.”

The ripple-effect of a resolution shortly after the Dec. 31 deadline, says Jimmy Jean of Desjardins Capital Markets, would likely have more in common with the debt-limit crisis of August 2011 than the Lehman Brothers collapse of 2008, after which the world plunged into the Great Recession.

“(The 2011 shock) wasn’t long enough to disrupt the economy,” Jean noted. “Even though it was a nightmare on financial markets, it didn’t have that big of an impact because it didn’t last long enough to really touch business and households.”

Credit rating agencies downgraded U.S. debt and markets took a nosedive, but equities recovered just as quickly when Republicans and Democrats agreed to extend the limit so the government did not default on its loans. Economic output, however, remained positive, although the loss of confidence likely kept growth from being stronger.

The scenario changes if both sides dig in their heels and refuse to budge, economists say.

The loss of confidence by business and consumers could be considerable, stalling investments, slowing employment and causing real disruption in the U.S. economy. It is unlikely in this environment that businesses would come to the rescue by expanding.

Much as in 2008-09, Canada would be sideswiped through direct and indirect channels.

A slump in the U.S. will be felt worldwide, which would drop demand and prices for natural resources Canada exports. Given that Canada ships about three-quarters of its exports across the border, the hit on exporters would be widespread, impacting the auto and parts sector, as well as oil and lumber producers.

“It would be a big shock,” said Jean. “The one positive is it would largely solve the U.S. fiscal problem” by virtually halving the deficit.

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